S&P Global Inc. quarterly report, Q3 FY2012

S&P Global Inc. (then The McGraw-Hill Companies, Inc.) — Q3 2012 Form 10-Q

Reporting period: Three and nine months ended September 30, 2012. The interim financial statements were reviewed by Ernst & Young, not audited. The filing reports the company under its then-current name, The McGraw-Hill Companies, Inc.

Business context and reporting period

The company operated four reportable segments: Standard & Poor’s Ratings; S&P Capital IQ / S&P Indices; Commodities & Commercial (C&C); and McGraw-Hill Education (MHE). It was pursuing a separation of MHE from McGraw-Hill Financial, by spin-off or sale, and expected to be positioned to separate by the end of 2012. The 2011 Broadcasting Group results are presented as discontinued operations following its sale in December 2011.

Financial performance and position

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Revenue	$1.953 billion	$1.908 billion	$4.830 billion	$4.726 billion
Operating profit	$528 million	$607 million	$1.114 billion	$1.180 billion
Net income attributable to the company	$314 million	$366 million	$652 million	$696 million
Diluted EPS	$1.10	$1.21	$2.29	$2.27
Operating margin	27%	32%	23%	25%

Revenue increased 2% in both the quarter and year-to-date period. Service revenue rose 16% in Q3 and 9% year to date, while product revenue declined 11% and 10%, respectively.
Q3 operating profit fell 13% and company-attributable net income fell 14%. Year-to-date operating profit declined 6% and net income declined 6%; diluted EPS rose 1%, supported by a lower average share count.
Segment revenue and operating profit, respectively: S&P Ratings grew 22% and 24% in Q3; S&P Capital IQ / S&P Indices grew revenue 13% but operating profit declined 11%; C&C grew 5% and 17%; MHE declined 11% and 20%. MHE’s nine-month revenue and operating profit fell 10% and 13%.
Cash from operations was $847 million for the first nine months, down from $1.038 billion. Free cash flow, the company’s non-GAAP measure after prepublication investment, capital expenditures and dividends, was $420 million versus $627 million.
At September 30, cash and equivalents were $1.243 billion; total debt was $1.199 billion, including $400 million due November 15, 2012. Current assets were $3.259 billion and current liabilities $3.358 billion. The company reported $1.2 billion of available commercial-paper capacity under its credit facility and said it had not drawn on it.
Quarterly and year-to-date dividends declared per common share were $0.255 and $0.77, respectively. Nine-month shareholder repurchases totaled $269 million in cash flow statements.

Material changes versus the prior comparable period

Growth and Value Plan costs were $99 million in Q3 and $174 million year to date, contributing to higher selling and general expenses and weaker consolidated operating profit. Excluding these plan costs, year-to-date selling and general expenses increased $2 million, according to management.
Service-oriented financial information and ratings revenue grew, including from strong debt issuance and 2012 acquisitions. The June formation of S&P/Dow Jones Indices contributed to revenue; the company owns 73% and consolidates the venture.
MHE weakness reflected lower school adoption and open-territory sales, a smaller adoption market, and revenue deferrals for programs with digital content delivered over multiple years. The filing also cites growth in used-book and rental markets affecting higher education print sales.
Year-to-date operating cash flow was lower, partly due to tax-payment timing, the absence of a prior-year tax refund, higher receivables and lower pension benefit accruals. Financing cash outflows fell substantially year over year, primarily because share repurchases were lower.
The 2011 comparison included a $13 million gain on the sale of LinkedIn shares, reported in other income, and small losses from discontinued Broadcasting operations.

Outlook, management commentary, risks and unusual items

Management expected to be positioned to separate MHE by year-end 2012, subject to transaction structure, regulatory approvals, market conditions and final Board approval. A favorable IRS ruling supported tax-free treatment of a spin-off; a potential sale remained under consideration.
Management estimated approximately $50 million of additional one-time separation expenses and approximately $25 million of additional restructuring expense for the fourth quarter of 2012. These were estimates, not earnings guidance.
Management described cash on hand, operating cash flow and the credit facility as sufficient for foreseeable operating and recurring cash needs, including the November 2012 note maturity. Business seasonality, particularly education publishing, affects cash flow.
Risks cited include economic and credit-market conditions, regulatory changes, foreign-exchange movements, education funding and adoption trends, and execution, timing, cost and operational effects of the proposed MHE separation. The company also noted possible increased volatility and reduced diversification after a separation or sale.
The DOJ and SEC were investigating potential civil-law violations related to S&P structured-product ratings. The company said it would defend the matters and believed pending legal proceedings and investigations would not have a material adverse effect, while noting outcomes and potential losses could not be predicted with confidence.
The S&P/Dow Jones Indices minority interest was recorded as redeemable noncontrolling interest, $810 million at quarter-end. Its agreement includes put/redemption provisions, including a minority-partner right beginning after December 31, 2017 and following a change of control.
The company recorded a $50 million Q3 restructuring charge tied primarily to severance and an approximately 520-position workforce reduction. It also reported that the U.S. defined-benefit pension plan was frozen effective April 1, 2012.

Most important facts for investors to verify

Whether and how the MHE separation or sale was completed, including final timing, approvals, transaction costs and effects on the remaining company.
Whether MHE’s school-market revenue declines and digital-content revenue deferrals continued, and how seasonal results affected full-year performance.
Whether financial-market issuance and related S&P Ratings revenue remained strong after the unusually high Q3 comparisons, and whether subscription growth translated into segment profit.
Actual fourth-quarter separation and restructuring costs versus management’s estimates, and the resulting impact on margins and cash flow.
Repayment or refinancing of the $400 million notes due November 15, 2012, and the company’s liquidity and credit-facility availability.
Developments in the DOJ/SEC ratings investigation and other legal matters, as well as any changes to potential exposure.
The final purchase-price allocation and valuation of the Dow Jones Index business and redeemable minority interest; the filing said estimates remained preliminary and could change.